Matthew Casey: Breaking down the debt crisis in simple terms

Matthew Casey

Friday

Aug 19, 2011 at 12:01 AMAug 19, 2011 at 6:15 PM

The debt ratio increased to over 60 percent under Reagan, dropped to under 60 percent during the Clinton administration, then it rose to over 80 percent under George W. Bush. Under Obama, the debt ratio has risen to over 98 percent of GDP.

Standard and Poor’s, a private financial services company, recently lowered its credit rating for the United States government.

According to S&P, its action was justified because our “elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden …”

The fact that the U.S. carries enormous debt and is saddled with incompetent political leadership is hardly news to most sentient beings. Regardless, the reaction to the downgrade by the financial experts who control the stock market was predictable: They panicked.

On the Monday following the S&P downgrade, the Dow Jones Industrial Average dropped 634 points. Then, on consecutive days, it rose 429 points, dropped 519 and rose another 423 points. Such volatility almost makes you wish they’d start working on the next bubble so they can finally complete the destruction of our collective retirements.

The root of all this anxiety is the national debt, which many fear has become so large that the federal government may eventually default on its financial obligations, an unprecedented event that could have catastrophic consequences for the global economy.

So how did we get here?

Government budgets are similar to other budgets: money comes in (tax revenues) and money goes out (expenditures). If revenues exceed expenditures during a given budget year, the result is a surplus. If expenditures exceed revenues, the result is a deficit.

To spend more than it takes in, the government borrows money by selling bonds. Bond sales provide an infusion of money today in return for the promise to repay the principal with interest at a later date.

While a deficit refers to a shortfall that may occur during a single budget year, the debt represents the cumulative amount owed by the government. If you run a lot of annual deficits without paying them off, you’ll end up with a pretty big debt.

There are perfectly legitimate reasons to incur debt: private businesses leverage debt to maximize growth; governments regularly borrow money to cover unexpected shortfalls associated with natural disasters; governments borrow money for the purpose of military actions and economic downturns. The problem is that the federal government has taken a strategic financial practice and made it standard operating procedure.

After his election in 1980, Ronald Reagan implemented tax cuts and increased government spending to help the nation recover from the “stagflation” era of the 1970s. While the economy grew and tax revenues increased, government spending increased at an even faster pace. Instead of cutting expenditures and raising revenue to pay down the debt as the economy recovered, the government pushed deficit spending to levels not seen since World War II.

The Reagan era never produced a single balanced budget. By the end of his second term, the U.S. had gone from the largest creditor nation in the world to its largest debtor.

After four years of surpluses in the late 1990s — the only surpluses posted during the last 42 years — it was predicted that the government would continue to run an annual surplus for another 10 years. Shortly thereafter, the Bush-era tax cuts were enacted. Since the cuts were implemented, it is estimated that tax revenues have declined between $1.3 and $2.8 trillion.

While tax revenues dropped, the wars in Iraq and Afghanistan increased spending by $1.26 trillion. After the economic collapse in 2008, the contracting economy reduced tax revenues even more, and spending again increased by hundreds of billions of dollars because of massive bailouts and stimulus packages under presidents Bush and Obama.

The national debt broke the $1 trillion mark for the first time in 1982. It topped $2 trillion in 1986, $3 trillion in 1990, $5 trillion in 1996, $6 trillion in 2002 and $10 trillion in 2008. The current US debt is $14.46 trillion, or about $44,000 for every person in the United States.

Government spending over the next five years is expected to exceed tax revenues by about $1 trillion per year. The interest alone on the national debt accounts for nearly 1 out of every 5 dollars collected in taxes.

This clearly isn’t a problem that developed overnight. For decades, Americans have simply become used to living on borrowed money.

The debt ratio — expressed as the percentage of the total outstanding debt compared to the gross domestic product of the U.S. — was under 40 percent during the economic malaise of the Nixon, Ford and Carter administrations. The debt ratio increased to over 60 percent under Reagan, dropped to under 60 percent during the Clinton administration, then it rose to over 80 percent under George W. Bush. Under Obama, the debt ratio has risen to over 98 percent of GDP.

Based on the preceding, one could argue that the economy has actually been floundering for the last 40 years, and that our perceived standard of living is little more than a debt-fueled illusion — one paid for at the expense of our children’s futures.

We are quickly arriving at a point in history when we have to recognize an obvious consequence of our profligate deficit spending: sooner or later, we’ll have to pay the money back. So far, only vague solutions have been offered: cut spending, cut taxes, raise taxes or hope for some kind of miraculous economic growth.

It remains to be seen what action will be taken or whether any action will be taken at all, given the obstinate partisanship and persistent inertia on the part of Congress.

The only certainty is that whatever happens, it’s going to hurt. A lot.

Read more from Matthew Casey at matthewcasey.net.

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